Flexible Budgets and Standard Costs

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Flexible Budgets andStandard Costs

• Chapter 24

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Objectives

• Prepare a flexible budget for the income
  statement
• Use the flexible budget to show why actual
  results differ from the static budget
• Identify the benefits of standard costs and learn
  how to set standards
• Compute standard cost variances for direct
  materials and direct labor
• Analyze manufacturing overhead in a standard cost
  system
• Record transactions at standard cost and prepare
  a standard cost income statement

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Static Budgets
Static Budget
(8 Pools)
Expected Output Volume Only
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Static Budgets
Oasis Pools Comparison of Actual Results with
Static Budget For the Month Ended May 31, 2005
Actual Static Results
Budget Variance Pools
10 8 2
F Revenues 150,000 120,000 30,000
F Expenses 119,000 95,000 24,000
U Income 31,000 25,000 6,000 F
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Static versus Flexible Budgets
Flexible Budget
(5 Pools)
(8 Pools)
(10 Pools)
Range of Output Volumes
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Flexible Budgets
Budgeted sales price per pool is
15,000. Budgeted variable expenses per pool are
10,375. Total budgeted fixed cost is 12,000.
What are the flexible budgets for Oasis
Pools when expected volume is 5, 8, and 10 pools?
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Flexible Budgets
Oasis Pools Flexible Budgets
Units 5 8 10 Sales
revenue Variable expenses Fixed
expenses __________________________ Operating
income
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Graphing the FlexibleBudget Formula
Total cost line
115,750
95,000
Variable cost 10,375 per pool installed
63,875
Fixed cost 12,000 per month
12,000
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Graphing the FlexibleBudget Formula
The flexible budget graph shows budgeted expenses
for 10 pools.
Variable expenses 103,750 Fixed expenses
12,000 Total expenses 115,750
May actual expenses were 119,000. They exceeded
the budget by 3,250.
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Oasis Pools Performance Report
Actual Flexible Static
Results Budget Budget Pools
10 10 8 Revenues 150,
000 150,000 120,000 Variable expenses
105,000 103,750 83,000 Fixed expenses
14,000 12,000 12,000 Total
expenses 119,000 115,750
95,000 Income 31,000 34,250 25,000
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Oasis Pools Performance Report
Want to know why there are variances.
Flexible Budget 34,250
Actual Results 31,000
Static Budget 25,000
3,250 U
9,250 F
Sales Volume Variance
Flexible Budget Variance
Static Budget Variance (6,000)
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The Flexible Budgetand Variance Analysis

• The flexible budget variance is the difference
  between what the company spent at the actual
  level of output and what it should have spent to
  obtain the actual level of output.
• It highlights the difference between actual costs
  and flexible budget costs.

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The Flexible Budgetand Variance Analysis

• Oasis Pools actually incurred 105,000 of
  variable costs to install the 10 pools.
• This was 1,250 more than the 103,750 budgeted
  variable cost for 10 pools.
• Oasis Pools also spent 2,000 more than budgeted
  on fixed expenses (14,000 12,000).

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How do managers develop flexible budgets?

• Standard Costing

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Benefits of Standard Costs

• They help managers plan by providing the unit
  amounts, which are the building blocks of
  budgeting.
• They help simplify record keeping.
• Standard costs are carefully predetermined costs.
  (price standards)
• Standard quantity often is referred to as the
  quantity that should have been used. (quantity
  standards)

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Direct Material Variances

• Price Variance measures how well the business
  keeps unit prices of materials and labor within
  standards.
• Efficiency Variance measures whether the quantity
  of materials or labor used to make the actual
  number of outputs is within the budget.

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Price Variance...

• is the difference between the actual price and
  standard price of inputs used multiplied by the
  actual quantity of inputs.
• Price variance (Actual quantity Actual price)
  (Actual quantity Standard price) or...
• Actual quantity (AP SP)

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Efficiency Variance...

• is the difference between the actual and
  standard quantity of inputs allowed multiplied by
  the standard price of input.
• Efficiency variance (Actual quantity Standard
  price) (Standard quantity Standard price)
  or...
• Standard price (AQ SQ)

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Example of Standard Costing
Variance analysis begins with a total variance
to be explained in this example, 3,250.
Actual variable expenses 105,000 Flexible
budget 103,750 Difference 1,250
Actual fixed expenses were 2,000 more than
budgeted.
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Materials Variances
Standards
Direct materials cost was 3.575 per cubic
foot. Materials allowed (gunite) was 1,000 cubic
feet per pool.
Actual Results (10 pools were built)
AP paid per cubic foot 3.00 AQ of materials
used 12,000 cubic feet
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Materials Variances
Price variance ?
Efficiency variance ?
Flexible budget variance ?
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Direct Labor Variances

• Price Variance measures how well the business
  keeps unit prices of materials and labor within
  standards.
• Qty x (AP SP)
• Efficiency Variance measures whether the quantity
  of materials or labor used to make the actual
  number of outputs is within the budget.
• Standard Price x (AQ SQ)

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Labor Variances
Standards
Direct labor cost was 6,000 per pool. The rate
was 15 per hour. Standard hours per pool were
400.
Actual Results (10 pools were built)
AP (actual rate) was 16.10 per hour. AQ (actual
hours) was 3,800.
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Labor Variances
Price (or rate) variance ?
Efficiency variance ?
Flexible budget variance ?
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Flexible Budget Variancesfor Materials and Labor
Flexible budget variance for materials 250
U Flexible budget variance for labor 1,180
U Total variances 1,430 U
Total flexible budget variance 3,250
U Materials and labor variances 1,430
U Flexible budget overhead variances 1,820 U
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Manufacturing Overhead Variances

• The flexible budget variance for manufacturing
  overhead shows whether managers are keeping total
  overhead costs within the budgeted amount for the
  actual production of the period.
• The production volume variance arises when actual
  production differs from the level in the static
  budget.

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Allocating Overhead to Production

• Oasis Pools allocates manufacturing overhead to
  production based on standard direct labor hours
  for the actual number of outputs.
• The static budget, which is based on expected
  output of 8 pools, is known at the beginning of
  the period.

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Allocating Overhead to Production
Standards
Variable overhead cost was 800 per
pool. Standard hours per pool were 400. Fixed
overhead cost was 12,000.
Actual Results (10 pools were built)
Actual variable overhead was 7,820. Actual hours
were 3,800, fixed overhead was 14,000, and total
overhead was 21,820.
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Allocating Overhead to Production

• In a standard cost system, manufacturing overhead
  is allocated to production based on a
  predetermined overhead rate.
• Most companies base their predetermined overhead
  rates on amounts from the static (master) budget
  which is known at the beginning of the year.

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Allocating Overhead to Production
Oasis Pools Budget Data for the Month Ended May
30, 2005
Budget type Static
Flexible Pools 8
10 Standard direct labor hours 3,200
4,000 Overhead cost Variable 6,400
8,000 Fixed 12,000
12,000 Total 18,400 20,000
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Allocating Overhead to Production
Standard variable overhead rate per hour
Standard fixed overhead rate per hour
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Total ManufacturingOverhead Variance...

• is the amount of underallocated or overallocated
  manufacturing overhead.
• This is the difference between actual
  manufacturing overhead and allocated
  manufacturing overhead.

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Total ManufacturingOverhead Variance
How much standard overhead is allocated to
production?
Variable Fixed Total
Total manufacturing overhead cost variance
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Total Manufacturing Overhead Variance

• The total manufacturing overhead variance is
  split into the manufacturing overhead flexible
  budget variance and the production volume
  variance.
• Overhead flexible budget variance is the
  difference between actual overhead and the
  flexible budget overhead.
• Production volume variance is the difference
  between flexible budget overhead for actual
  output and standard overhead allocated for actual
  output

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Overhead Flexible Budget Variance
Oasis Pools a comparison of actual results
with the flexible budget overhead for actual
production
Actual Results Flexible Budget
Variance Pools 10 10 Overhead
cost Variable 7,820 8,000 180
F Fixed 14,000 12,000 2,000
U Total 21,820 20,000 1,820 U
Overhead flexible variance is 1,820 unfavorable.
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Production Volume Variance...

• is the difference between the overhead cost in
  the flexible budget for actual production and the
  standard overhead allocated to production.
• 4,000 3.75 15,000 standard allocated for
  fixed overhead
• How much is the volume variance?

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Total Overhead Variances
Flexible budget variance 1,820 U Volume
variance 3,000 F Total 1,180 F
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Flexible Budget Variance
Flexible budget variance 3,250 U
Materials 250 U Labor 1,180
U Flexible budget for overhead 1,820
U Total 3,250 U
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Total Variances

• Why was actual income 3,250 less than the
  flexible budget for 10 pools?
• Variable costs exceeded the flexible budget by
  1,250 and actual fixed costs exceeded the static
  budget by 2,000.

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Standard Costs in the Accounts
What is the entry to record the purchase of
12,000 cubic feet of materials (actual price paid
was 3.00 per cubic foot and the standard being
3.575/cubic foot)?
Materials Inventory 42,900 Direct
Materials Price Variance 6,900
Accounts Payable 36,000 To record
purchases of direct materials
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Standard Costs in the Accounts
What is the entry to record the transfer
of 12,000 actual cubic feet of materials to work
in process inventory?
Work in Process Inventory 35,750 Direct
Materials Efficiency Variance 7,150
Materials Inventory 42,900 To record use
of materials 10,000 standard cubic feet 3.575
standard price
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Standard Costs in the Accounts

• Notice that in these entries, the direct
  materials price variance is recorded at the time
  of purchase.
• An unfavorable variance has a debit balance which
  increases the expense.
• A favorable variance has a credit balance in the
  accounts and is a reduction in expenses.

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Standard Costs in the Accounts

• Manufacturing Overhead 21,820
• Accounts Payable,
• Accumulated Depreciation,
• and Other accounts 21,820
• To record actual overhead costs incurred

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Standard Costs in the Accounts
What is the entry to record allocated manufacturin
g overhead?
Work in Process Inventory 23,000 Manufacturing
Overhead 23,000 To allocate overhead
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Other Entries
Finished Goods Inventory 118,750 Work in
Process Inventory 118,750 To record completion
of 10 pools
Cost of Goods Sold 118,750 Finished Goods
Inventory 118,750 To record sale of 10 pools
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Closing Variances
Unfavorable Variances
Materials efficiency 7,150 Labor rate
4,180 Flexible budget 1,820 Total 13,
150
Favorable Variances
Materials price 6,900 Labor efficiency
3,000 Production volume
3,000 Total 12,900
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Closing Variances
13,150 unfavorable 12,900 favorable 250
unfavorable
Income Summary 250 Net Variance 250 To
close various variances
This entry increases the cost of goods sold.
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Standard Cost Income Statement for Management
Standard Costing Revenues 150,000 Cost
of goods sold 118,750 Unadjusted income
31,250
Actual Costing Revenues 150,000 Cost
of goods sold 119,000 Adjusted income
31,000
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Standard Cost Income Statement for Management

• Closing the 250 net unfavorable variance to
  income summary increases the cost of goods sold
  to 119,000.
• This produces the 31,000 income figure.

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Review

• Flexible Budgets
• Standard Costing
• Direct Material Variances
• Direct Labor Variances
• Manufacturing Overhead Variances

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End of Chapter 24